India: Debt Investments By FPIs: Prescriptiom Of VRR For The Ailing Debt Market

Last Updated: 26 March 2019
Article by Tanushree Bhuwalka and Aman Dwivedi

Most Read Contributor in India, July 2019

In the recent past, foreign portfolio investment (FPI) route had become a dominant source of foreign investments in India. Nearly, 600 new FPIs were registered with the Securities and Exchange Board of India (SEBI) in the last year itself, taking the count to almost 1,000 active FPIs in the country. However, owing to several global economic forces at play, such as, sharp depreciation of the Indian Rupee, debilitated economic fundamentals, and a knee-jerk reaction to the implementation of concentration norms in mid-2018, the last year witnessed the highest net withdrawal from debt markets in India which stood at INR 49,593 crores, in a big turnaround from 2017, which garnered net inflows amounting to INR 1,50,000 crores.

While the concentration norms have been successfully implemented in other financial services sectors to mitigate systemic risks in the financial markets, implementing this restriction on debt subscription attracted criticism on account of limiting the flexibility of a route that was an important avenue for fund raising by Indian corporates.


Taking cognizance of the critical comments from several stakeholders on the implementation of concentration norms on debt investments by FPI (as detailed below), the Reserve Bank of India (RBI) on 1 March 2019 (VRR Circular) introduced the Voluntary Retention Route (VRR) with a view to boosting foreign investment in Indian debt markets. For amounts invested through VRR, FPIs will be eligible to claim exemption from minimum residual maturity requirement and concentration norms, provided they agreed to maintain a minimum of 75% of their investments in India (including via follow-on investments) for a voluntarily agreed retention period of at least 3 years. Investments through the VRR are capped at INR 40,000 crore for government bonds (ie, G-Secs, Treasury Bills and State Development Loans) and at INR 35,000 crore for corporate bonds (ie, non-convertible debentures, bonds or commercial papers issued by an Indian company; security receipts issued by ARCs or securitization companies, etc), which will be kept open till 30 April 2019.

The RBI has clarified that the amounts of investment under the VRR shall be calculated only in terms of the face value of securities and not otherwise. The RBI has however kept units of domestic mutual funds outside the ambit of VRR scheme.

Allocation mechanism of CPS under VRR

Allocation of investment amount to FPIs under VRR shall be made through auctions, or on tap, on a 'first come first served basis' by the Clearing Corporation of India Limited (CCIL). The notification prescribing operational details of application and allotment is awaited from CCIL. With a view to diversifying and expanding the debt market, the RBI has specified that in cases of demand for allotment being more than 100% of amount offered for each round of auction or allotment on tap basis, an FPI (including its related FPIs) shall not be allotted an investment limit greater than 50% of the amount offered in each such round.

Some of the salient features of the mechanism notified by the RBI for the auction process for allotment of investment amounts under VRR are:

  1. criterion for allocation of investment amount under each auction shall be the retention period and bids by FPIs will be accepted in descending order of retention period, until the amounts of accepted bids add up to the auction amount;
  2. in case the amount bid at margin is more than the amount available for allotment, the criterion for allocation shall be the amount proposed to be invested, and in case the amount offered is the same for two or more marginal bids, the amount shall be allocated equally;
  3. flexibility to place multiple bids in an auction and reckoning of 'committed portfolio size' (CPS) for each bid separately; and
  4. allocation of CPS to an FPI under an auction shall not preclude such an FPI from participating in subsequent auctions.

Hedging of exchange risk under VRR

The RBI in a separate notification allowed authorised dealers to offer derivative contracts to participants under the VRR to enable FPIs to hedge their interest rate and exchange rate risk on account of investments made under the VRR scheme. The products available for hedging purposes are forwards, options, cost reduction structures and currency swaps with Indian Rupee as one of the currencies.

Portfolio management by successful allottees

Once selected under the VRR, successful allottees will be required to invest 25% of their CPS within 1 month and the remaining amount within 3 months, from the date of allotment. The VRR Circular has specified that the retention period will commence from the date of allotment of limit and not from the date of investment. Prior to the end of the committed retention period, an FPI, may opt to continue investments under VRR for an additional identical retention period. However, if an FPI chooses not to continue under VRR at the end of the retention period, it may liquidate its portfolio, or may shift its investments to the 'general investment limit', subject to availability of limit.

Investments under 'general investment limit' shall be subject to minimum residual maturity requirement and concentration norms, as notified by RBI last year vide its circular dated 15 June 2018.


Minimum Residual Maturity

In the wake of constraints faced by FPIs in providing short term debt financing in India on account of restriction of minimum residual period being 3 years (applicable to primary subscriptions, as well as secondary acquisition of non-convertible debentures (NCD), the RBI reduced the minimum maturity period from 3 years to 1 year in April 2018. This relaxation is subject to the condition that short-term investments in corporate bonds by an FPI does not exceed 20% of the total investment of that FPI in corporate bonds.

Concentration Norms

Investments by an FPI (together with its related FPIs) outside the VRR, continue to be subject to the concentration norms and cannot exceed 50% of the issuance of NCDs by an Indian corporate. In addition to the single issuance concentration norms, the RBI had previously also prescribed 20% of the debt portfolio of the FPI (together with its related entities) as the limit of exposure of an FPI into a single corporate. However, the RBI on 15 February 2019, in keeping with its intent to diversify and expand the investor base of the debt market, withdrew the 20% group concertation limit. This proactive approach of the regulator in resolving genuine concerns of offshore investors has been welcomed by the market players and has also provided a further impetus to the FPIs.

Growth of AIF as an alternate vehicle for debt funding in 2019?

As a reaction to the introduction of concentration norms under debt investment rules for offshore entities, investors had started exploring Alternative Investment Funds (AIFs) as a substitute investment vehicle for debt subscription. Several FPIs have successfully used the AIF route to make debt investments in India which provide foreign investors the latitude to participate in varied types of private debt issuances. Investments in AIFs increased to approximately 30% in 2018, as long-term FPIs which have significant exposure to Indian debt portfolio have started routing their investment through a tax-passthrough category II AIF. Routing of investment through a tax-passthrough category II AIF has also aided the investors in avoiding tax leakages. Given that AIFs are considered as domestic entities and any money pooled by an AIF is considered as domestic investment, if the manager of such AIF is owned and controlled by Indians, limited investment restrictions are attracted on AIFs, especially in the debt sector.

Investors had started exploring AIFs as a mode of investing in the debt portfolio during 2017 when such investments reached an all-time high of debt investments in 2017, wherein the debt limits for FPIs were getting rapidly exhausted. It now remains to be seen how 2019 will unfold to garner popularity of AIF structures as a preferred mode of raising offshore debts in light of imposition of investment limitations to FPIs or whether the VRR scheme will prove to be the much-needed prescription for the recently troubled debt sector under the FPI regime.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at

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